One challenge that is peculiar to all Micro Small and Medium Enterprises (MSMEs) is that of funding. Of course, the level of challenge depends on the size of the business and the plan that needs to be executed. It is even more so for start-ups looking for funds to bring their business ideas to life.
To solve this challenge, entrepreneurs and business managers explore several sources including applying for loans, grants, partnerships and so on.
Equity financing is a reliable funding option. It basically involves giving out some equity or ownership in your business, in exchange for capital. This could come from friends, family members or potential business partners, and it is often aimed at raising money to pay short-term bills or financing long-term expansion plans.
Recently on the weekly Nairametrics “Business Half Hour” with Ugodre, Tokunboh Ishmael, Co-Founder and Managing Director of Alitheia Capital, discussed the topic “Private Equity Funding for SMEs” in detail.
Among other things, Tokunbo gave some pointers as to how business owners could attract the right equity financing for their business options. The points summarized below tell you what potential equity finance partners (individuals or partners) look out for.
Management (Who is the manager?)
Any company or individual who puts up money for your business, in exchange for equity, is definitely concerned about the management.
They want to know if the manager of the business has had any experience managing a similar business before. This is considered a form of apprenticeship and it is expected that whatever knowledge gained would help make you more efficient in dealing with issues that may arise in the course of the business.
Does he have the requisite educational background? It does not always take someone with a Masters in Business Administration (MBA) to grow a successful business. But that MBA degree could suffice, especially when you do not possess any other relevant experience.
Do you have the relevant track record? What happens if you have overseen a business which eventually went bankrupt or crashed due to management problems? Does this make the Equity fund partner more or less willing to put money into the business? Obviously not!
Some people can wake up and be successful entrepreneurs at first try, but this is not usually the case. Most will go through years of rising and falling, or working under others to gain the relevant experience of running a business.
Management is a critical point that any company or individual will look at, when you approach them with the offer of equity in exchange for funding.
Opportunities (What opportunities does it bring to the investor?)
Every business idea is an attempt to solve a problem. But what separates successful business ideas from others is that there is something unique about your solution.
First identify and understand the problem you want to solve, and from there work out a sustainable business solution. Every equity investor will be concerned with the uniqueness of your solution. Is it peculiar to you? Or is it something that everyone else is doing?
If your business idea has an easy entry point, meaning your idea is not unique to you, it would be difficult to get equity funding. Why? The potential investors already understand that you would soon have to deal with serious competitors who might end up doing what you do even better.
If your business idea shows a potential to make investors part of something big and unique, then you are more likely to get the funds you need. No company or individual wants to invest money in a business idea that will soon be drowned by competition.
You may get some sympathy funds from family members and maybe friends, but not any significant sum that will take you far.
ROI (How soon can investors get returns?)
Returns on Investment (ROI) are a key consideration for any investor (except perhaps charity organisations).
An investor’s concern with returns can best be likened to a retiree’s concern with pension. It is a most sacred topic and in fact, one of the first things they want to find out before putting in their money.
Based on your business idea and model, do I have to wait a year, two or three years before getting any returns?
A quarter may be too short to expect returns, but maybe three years would also be too long to wait. It all depends on your business venture, and of course, the investor’s plans. If he has plans to start channeling the returns into other ventures within six months, then a two-year wait would not be for that investor.
Returns are not always financial, they could also be social. If the equity company is one that is more disposed towards a certain sector of the economy, say tech or agriculture, then the success of the company brings not only financial returns, but social returns to the company.
This is something you should also look out for before approaching any company for equity funding. You do not want to approach a company with an agricultural business idea, when the company is more disposed towards technology or education.
Ability to scale (Is the business expandable and replicable?)
A private equity partner is also concerned about how soon your business can expand, and how replicable your strategy is. Can it scale up?
Do you have a business idea that is so built around you, that it cannot function without you? Do you have a business idea or structure that will likely crumble if you die? Do you have a process that can be replicated?
The investor wants to know for sure that there are growth and expansion potentials. There is a need to be sure that the business idea you have is not one that can only remain confined to your bedroom. They want to know that you can move from offering your services in one state to serving several states and even the global community.
Why is this even necessary?
Because, it affects how attractive the business will become to the next level of investors who will take over from the private equity investors. This leads us to the next point they consider.
Exit potential (How can they sell out their equity and exit the company?)
Private equity investors are often not interested in taking over your business from you. Their aim is to bring in money for you when you are starting up, provide you advice and partnership, and sell out when it grows. They are not interested in having investments in different sectors of the economy. This explains why they are often concerned about the exit potential in your business.
Is there the likelihood that we can exit sometime in the future? Or do we just invest and get stuck? How attractive can this business become for the next level of investors – the institutional investors who will come in to own the business with you and stick to the end?
One of the most frightening possibilities to the private equity investor is that when he is ready to exit, there is no one to buy in and take over. So you need to answer the question – how attractive is your business idea to investors, and what is the exit potential?
If all five questions are dealt with satisfactorily, then you are well on your way to getting a good private equity partners to provide you financing for your business.